Funding Water Services & Infrastructure

1. Funding Water Services & Infrastructure Brent Layton Friday 21 September 2007

2. Overview • Local Government Rates Inquiry • General principles of public finance • Current funding of water services & infrastructure • How should water services & infrastructure be funded • Conclusions

3. Local Government Rates Inquiry • Three person panel chaired by David Shand reported in August 2007 • NZIER assisted the Panel with analysis of possible new sources of funding for local government • Very high quality report • Focused • Clear recommendations • I draw heavily on the report in this presentation

4. General principles of public finance • Efficiency principles • Allocative efficiency • Funding assists in ensuring the allocation of resources so you produce the right quantities of various outputs taking into account transaction costs (e.g. no use charge tends to encourage overuse) • Productive efficiency • Funding contributes towards using the lowest economic cost to produce the service or output (e.g. how much efficiency driver does it put on the provider) • Dynamic efficiency • Funding contributes towards making optimal investments decisions (e.g. do those driving need for expansion face cost)

5. General principles of public finance • Equity principles • Horizontal equity • People in similar situations should face similar charges • Intergenerational equity • Assets that will be around for a long time should not be all paid for by today’s consumers • Current costs should not be funded by borrowing to paid for by future consumers • Ability to pay? • Socking it to them because they can pay and have no choice? • You can’t get blood from a stone? • How much should income wealth issues be dealt with by differential pricing rather than income transfers?

6. Current funding • Rates • 2005 71% of local government expenditure on water and waste-water services was funded from rates • On average 22% of rates allocated to water services • User charges and fees • Only 27% TLAs using metering for at least some customers, although some big ones • Development contributions • s.106 of the Local Govt Act 2002 • Growing source of funding of capital costs

7. Current funding • Debt funding • Very little used • “the clear conclusion is that local authorities generally have very low levels of debt” (Shand Report p.155) • Transfers from government • MoH Drinking Water Assistance Programme • Pop <5,000 and high deprivation index and health risks • MoH Sanitary Works Subsidy Scheme • Pop < 10,000 and inadequate septic tank soakage • Tourism Department subsidy Scheme • Water and waste water in tourist areas – over subscribed

8. Current funding • Income from investments • Many LAs own business enterprises such as ports, airports, forests and farms • Many LAs have significant investments in bonds and shares • Year ended June 2006 – investment income equal to 6% of all operating revenue for LAs • Some of this money funds water services & infrastructure

9. How to fund: user charges • Water services ideal candidate for user charges as a private good • Charging for use ensures efficiency in use (10-15% reduction once charges introduced) • Should charge for all three forms of water (drinking, waste and storm) • Two part tariff seems desirable: • Fixed access charge • Variable volumetric charge

10. How to fund: user charges • Limits of user charges should be: • No less than incremental costs • No more than stand alone costs • Costs of monitoring low volume usage may mean that a standard charge for such users without metering may be justified on efficiency grounds • Otherwise, presumption should be close to 100% user charges to meet current costs of water services including current costs of the infrastructure capital (return on and of capital)

11. How to fund: rates • Not a suitable basis to fund the costs of water services & infrastructure • Property value and use of water services generally not causally related so charge and water use unrelated –allocatively inefficient • Places very limited incentive on provider to account for costs of production and ensure they are efficient –so productively inefficient

12. How to fund: rates • Does not have those driving need for investment seeing the costs clearly – so dynamically inefficient • Like users pay unlike amounts for service – so inequitable • If no debt used to fund then inter-generational inequity • Users of water services can be easily identified and relatively easily charged (even if metering not economic for small users)

13. How to fund: development contributions • Can be way to ensure that new comers see costs of their decisions and hence improve dynamic efficiency • Care necessary to ensure horizontal equity and that new comers are not double charged i.e. • Pay once in a lump sum for the capital investment • Pay again through user charges for the use of the capital they have already paid for • Should not be seen as a means to lump costs onto new comers (North Shore case) (horizontal equity) • The incremental costs/stand-alone limits to charges apply for the charges to be efficient

14. How to fund: debt • Important for inter-generational equity • Councils have low costs of borrowing compared with private citizens so more efficient for council to borrow and invest than to require residents to “borrow” and lend to council to invest – so productive efficiency for community as a whole • Current charges should cover: • Operating costs • Depreciation of capital • Return on capital invested • Debt-holder scrutiny can provide good discipline on management and governance of service – improves productive and dynamic efficiency

15. How to fund: public-private partnerships • If PPP’s are just used as a source of finance then questionable as councils can usually borrow on better terms than private organisations • If private partner brings expertise or greater discipline in planning, construction or operation then can be very useful. • Improves productive and dynamic efficiency • Good partners do this • Constraints at present on private involvement in water services provision inhibit potential improvements in efficiency

16. How to fund: transfers from government • Is possible to put together a case for some central government funding • E.g. costs meeting government minimum water standard being met by government will sharpen its incentive not to over regulate on quality • E.g. tourist locations – hard to charge tourists for the real water and sewage costs they impose and can be big burden on a small community that benefits little from passing traffic • Size and income level of community should not be a deciding criteria. May be a reason why inequitable or inefficient but the case should be a solid economic one as to why taxpayers should pay

17. How to fund: investment returns • Councils hold assets for two reasons: • “Strategic” • For the returns • Most “strategic” explanations turn out to be an excuse not to sell • a new owner is unlikely to manage the asset in a way that is detrimental to the local community. Indeed, often a new owner is likely to enhance the efficiency of operation of the local asset to the benefit of the community • Councils tend to only get good returns when they are able to exploit a strong monopoly position (see Shand Report) • Consumers are unlikely to be better off being exploited by a monopoly owned by the local council than they would be if the regulatory regime was improved and the asset sold and the capital used to fund infrastructure or returned to residents

18. Summary • Using rates to fund water services and infrastructure is not efficient or equitable • Two-part user charges (connection charge plus volumetric charge) should be the main element of charging • Well designed development contributions can have a role in improving dynamic efficiency • Using debt to provide part of the capital is important for inter-generational equity and efficiency

19. Summary • Transfers from government may be justified but need solid economic case • PPPs have a role if partner brings skills and discipline. As a source of funds alone, case not strong • Holding assets to partly fund services is unlikely to be in the best interests of the community overall